Stable Value
- Stable value, a strategy that continues to deliver
- Wrap contracts market stabilizes after shuffle
- Stable value, managers take on more conservatism
- Stable value, caught in regulatory mayhem
- Regulatory bodies asking for more disclosure, education surrounding stable value
- Barclays launches new index hoping to better capture stable value performance
- Stable value funds continue to outperform money market funds
Funds still beating competitors in retirement plans
Stable value continues to be a winner, outperforming numerous strategies and asset classes. That's according to David Babbel of The Wharton School at the University of Pennsylvania and Miguel Herce of Charles River Associates, two experts on stable value fund performance since the 1970s. The pair recently updated their economic literature on stable value performance through December 2009, which they released in January. Stable value funds were created in the late 1980s, although earlier forms of stable value funds have been around since the early 1970s, coinciding with the development of U.S. defined contribution plans. The returns have always been fully guaranteed by insurance contracts regardless of the performance of underlying assets in the portfolio.
They typically invest in high-quality, short-maturity – usually under five years – corporate and government bonds, mortgage-backed securities and asset-backed securities, and are protected by so-called wrap contracts, which guarantee book value in case of redemption. "From an investor's viewpoint, stable value funds operate like a passbook savings account," said Mr. Babbel and Mr. Herce. "They accrue interest at a prespecified rate that is generally updated every one to three months to incorporate changing market conditions. Their principal is secure and grows over time by the amounts of interest credited to their account."
But wrap capacity still needed remains north of $50 billion
The stable value industry, especially the industry for wraps, is finally calming down after significant changes in recent years following the financial crisis. Stable value funds performed relatively well during the crisis and for the most part continue to provide both returns and protection of principal as they've always been expected to. But because of excessive risk taking by some stable value fund managers in the years leading up to the crisis, wrap providers have been reshaping the industry, mostly by imposing higher fees and tightening investment guidelines.
Stable value is a major component of the retirement industry. These funds are available in most U.S. defined contribution plans, 457 governmental plans and 401(k) plans. The 25 members of the Stable Value Investment Association managed $437 billion in wrapped assets as of September 2010, and total stable value funds hold nearly $561 billion in 401(k) assets.
Tighter investment guidelines imposed by wrap providers
After excessive risk-taking in the years leading up to the financial crisis, stable value managers have centered their investment strategies on more conservative practices.
The move is due to the unexpected under-performance of highly-rated structured securities and pressure from wrap providers, which decided against insuring portfolios that had become too risky. The prospect that interest rates, which have been at historically low levels, are bound to rise soon is also prompting safer investments in stable value funds.
Some of the trends in investment practices at stable value managers include focusing on shorter durations and higher quality paper. They are also imposing more restrictions on competing funds.
Higher credit, shorter duration
"There's a general trend toward less credit exposure and shorter duration, two major risks that wrap providers had," said James King, senior vice president and head of stable value markets at Prudential Retirement.
SEC, CFTC to determine whether wraps are swaps in the fall
As Congress worked on revamping the financial services industry on the heels of one of the largest credit crisis in history, stable value got caught in the mix. As a result, the treatment of one of its staple features, the wrap contract, may potentially be in jeopardy
Indeed, some provisions intended to regulate swaps and derivatives in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 could have adverse unintended consequences that would negatively impact stable value participants.
Like wraps, credit default swaps are essentially insurance contracts between two parties, a protection buyer betting that a company, a bond, a loan or a sovereign will default, and a protection seller. The buyer pays an upfront amount plus annual premiums to the protection seller, which has to pay in full in case of a default. Because they are private contracts between two parties, swaps weren't previously regulated by any agency. They‘re also subject to counterparty risk, which means that if the seller doesn't have the money to cover the insurance in the case of a default, the buyer simply doesn"t get paid.
Next step could involve new rules for stable value players
In December, Sen. Herb Kohl (D-Wis.), the chairman of the Senate Special Committee on Aging, launched an investigation into the stable value world.
Aiming to protect the interests of the nation's seniors and elderly, especially those in 401(k) plans, who have to personally manage their retirement plans, he launched a broad investigation into stable value, with the goal of assuring plan participants fully understand the functioning of stable value funds.
"Unlike those covered by traditional defined benefit pension plans, participants in 401(k) plans personally contribute to their individual accounts and are responsible for selecting from an array of investment options, such as various mutual funds, offered by plan sponsors," Mr. Kohl wrote in a letter addressed to the industry, adding that plan sponsors are the ones ultimately responsible for selecting and monitoring 401(k) plan investments options. "I was troubled to learn that in recent months some plans' sponsors were limited in withdrawing money from their stable value funds," he added. "Therefore, I am very interested in learning more about stable value funds within qualified retirement plans."
Barclays Capital launched a stable value index late last year. Called the Stable Income Market Index, it is intended to serve as a market performance benchmark for asset portfolios within stable value funds.
The index is defined as a low-risk blend of asset classes from the Barclays Capital U.S. Aggregate Bond Index. It focuses on shorter maturities and provides diversified exposure to debt from the government, credit and securitized sectors.
"The launch of the stable income market index should help plan sponsors measure the performance of stable value asset managers against a benchmark that more fairly reflects the constraints imposed by wrap providers," said Lev Dynkin, head of quantitative portfolio strategy at Barclays Capital. "The index was developed by Barclays Capital Research at the request of, and in close consultation with, stable value market participants, including pension funds, asset managers, insurance companies and banks that provide insurance wraps for stable value funds to protect them from significant drops in market value versus book value."
When plan sponsors look for low-risk investment strategies coupled with capital preservation, there aren't too many options out there these days.
Stable value and money market funds both come to mind, but if sponsors are looking for strategies that also provide higher fixed-income returns, the stable value option is a no brainer, especially in the current low interest rate environment.
"Right now, money market funds are yielding 10 to 25 basis points," said Ron Heath, managing director of sales and marketing at Morley Financial Services Inc., which has $14 billion under management. "Stable value funds have provided participants returns of 2% to 4% over the past year and look attractive by comparison."
"Stable value funds are still offering returns north of money market funds and in line with intermediate bond funds," agreed James King, senior vice president and head of stable value markets at Prudential Retirement.
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